Market Commentary – March 31, 2013

The Life of Reilly is a fictional story that demonstrates some interesting analogies to today’s market environment. Mr. Reilly was a down-and-out stock analyst who hyped recommendations of other analysts. Rarely did he get money managers to return his calls.

On the train to work one day, Reilly picked up a crumpled copy of The Wall Street Journal bearing that day’s date and began to read it. He read that a particular stock had announced higher than expected earnings and the stock was up for the day. It was a typical mundane day until he looked at the closing stock prices at the end of the day. The stock he had read about that morning had announced higher earnings during the day and in fact did close higher – at the exact price he had seen in the paper that morning!

The next morning the scenario repeated. He went to the same section in the paper and read about the earnings and closing price of another stock. At the end of that day the stock closed just as the paper said. He decided to test the ability to peek into the future by calling portfolio managers and telling them about the stock. As usual, the managers paid him no attention, but the stock in question performed just as the paper – and Reilly — had said it would. This scene repeated and managers began to take notice and started to return his calls. The snowball started to roll and picked up momentum. Reilly could do no wrong! Unfortunately, his downfall wasn’t a bad stock recommendation but was the day he read in the paper that he had died. Other than dying, Reilly’s system worked to perfection. Perhaps if you see a crumpled up Wall Street Journal lying around you might be tempted to pick it up with hopes it will bring the same good fortune, except, of course, for the end. If only it was that easy!

Today the markets are moved by a myriad of factors, some obvious, some not so obvious, but it isn’t easy to get a direction, especially in the short-term. Despite the fact that many times you don’t have enough information to understand or compare, there is no absence of information or opinion these days.

Have you ever wondered where cable news channels get their information? There is a secret society that only the networks can access. They are sworn to secrecy at the threat of having their FCC license pulled. Their membership rivals the Skull and Bones secret society at Yale whose members are known globally; some are said to have even been Presidents. Their operation center is located in a bunker two miles deep in a remote mountain in Colorado. Their cover is a US military installation that is the purported command headquarters in the event of a nuclear war but is actually a depository of information related to the smallest detail about the stock market and economics. They have writers and analysts who specialize in hearsay and rumor, conspiracy theories, gossip, and social happenings and PhDs who are on the cutting edge of theoretical capitalism. Many of them end up in Washington working for various media organizations with a specialty in economics and stock market theory. They are tasked with confusing investors and have pioneered the theory and application of behavioral finance worldwide. Many have compared the noise — excuse me, meant to say news — to trying to get a sip of water from a fire hydrant. They have been so successful that they have created TV shows that are on 24 hours a day and on which all they talk about is the stock market.

Absent good advice from a trusted financial resource like The Trust Company, investors turn to these outlets for guidance. Who can argue with these people — they are experts on TV, right? However, do you really think a three-minute sound bite is something you want to rely on for directing your long-term investments? Oftentimes news outlets focus on technical information about the stock market. On March 14, 2013, the Dow Index breached its previous all-time high of 14,163.53 (reached on 10/9/07). On the last trading day of the first quarter, March 28, 2013, the S&P 500 exceeded its all-time high of 1565.15 (reached on 10/7/97). Are these milestones significant? Someone using a technical approach to investing looking at charts and price tendencies might think so. Our approach is more weighted to fundamentals about stocks, which include earnings, sales, debt, and cash on the balance sheet, etc. In both 2000 and 2007, excesses caused the peak in stock prices. In 2000 the “dot.com” bubble burst because of astronomical valuations, and in 2007 the weight of incredible leverage caused crisis in the financial system.

What is different now? There is good news in the consumer area, which makes up 70% of our GDP. The forward P/E of the S&P 500 (as of 3/12/13) stands at 13.7, which is significantly less than 25.6 in 2000 and below 15 in 2007. From a valuation standpoint, we are at fair value. From a corporate standpoint, net debt/equity is down 63% since 2007, which is an excellent financial position for companies. Additional good news is that our GDP is up more than 12% since October 2007 and borrowing costs are at historical lows, with the 10-year Treasury at 2.0% versus 4.4% in 2007. Corporate America has never been as profitable as it is today. All companies need is to increase sales.

Last year was a quiet year for the stock market. There were only six days when the market moved up or down by more than 2% as compared to 2011 when there were 34 days with those fluctuations. 2012 was especially quiet considering everything that was going on in world news: Egypt’s control by the Islamic Brotherhood, Israel and Gaza shooting missiles at each other, Iran’s continued pursuit of nuclear weapons, divisiveness in Washington, and the fiscal cliff. You may have expected a lot more volatility.

What does this mean? Are we going to have a new bear market? Probably not. Is the market going to go down? A pull back is due at some point. Historically, the market has averaged a 5% correction three times a year and a 10% correction once a year. The last significant decline was during August and September 2011 when the S&P 500 fell by more than 16%, from which it then recovered by early 2012. As we have always said, we are long-term investors and don’t think that you can time the market because you have to be right not just once, but twice. If a couple wanted to sell their long-term investments, they should first ask themselves the question, “have our goals changed recently?”

Like the Dow and the S&P 500, The Trust Company has hit its own milestone. We have broken the $2 billion mark of assets under management. We want to thank our clients because without you none of this would have been possible. We are proud of how much we manage but the most important measure to us is not only to meet your expectations but to exceed them.